Thousands of people flocked to Bethlehem's Manger Square on Christmas Eve as crowds of families and music and decorations heralded a much-needed boost of Christmas spirit after two years of war-tinged sombre celebrations.

The giant Christmas tree that was absent during the Israel-Hamas war returned on Wednesday, overlooking a parade of hundreds of smartly dressed scouts playing well-known Christmas songs on bagpipes.

The city where Christians believe Jesus was born cancelled Christmas celebrations for the past two years during the war in Gaza, holding muted celebrations few decorations or lights or festive events.

Cardinal Pierbattista Pizzaballa, the top Catholic leader in the Holy Land, kicked off Christmas celebrations during the traditional procession from Jerusalem to Bethlehem, calling for “a Christmas full of light.”

“After two years of darkness, we need light,” Pizzaballa, the Latin patriarch of Jerusalem, said as he crossed the separation wall that divides Jerusalem from Bethlehem.

Arriving in Manger Square, Pizzaballa said he came bearing greetings from Gaza's tiny Christian community, where he held a pre-Christmas Mass on Sunday.

But among the devastation, he also saw a desire for life and to rebuild.

“We, all together, we decide to be the light, and the light of Bethlehem is the light of the world,” he told thousands of people, Christian and Muslim, who gathered in the square.

Despite the holiday cheer, the impact of the war in the Israeli-occupied West Bank is acute, especially in Bethlehem, where around 80 percent of the Muslim-majority city’s residents depend upon tourism-related businesses, according to the local government.

The vast majority of people celebrating on Wednesday were local residents, with only a handful of foreigners mixed among the crowd.

But some residents said they are starting to see some small signs of change as domestic tourism slowly returns and hopefully will herald the return of international visitors the city depends on.

“Today is a day of joy, a day of hope, the beginning of the return of normal life here,” said Bethlehem resident Georgette Jackaman, a tour guide who has not worked in more than two years.

“People are desperate, but after two years, everyone wants to celebrate.”

Christmas and religious pilgrims always have been a prime economic engine for Bethlehem. During the Gaza war, the unemployment rate in the city jumped from 14 percent to 65 percent, Bethlehem Mayor Maher Nicola Canawati said earlier this month.

Despite the ceasefire that began in October, tensions remain high across much of the West Bank.

Israel’s military continues to carry out frequent raids in what it says is a crackdown on militants. Attacks by Israeli settlers against Palestinians have reached their highest level since the United Nations humanitarian office started collecting data in 2006. Israel captured the West Bank in the 1967 Mideast war.

The internationally recognised Palestinian Authority has limited autonomy in parts of the territory, including Bethlehem.

Palestinian President Mahmoud Abbas is expected to attend the midnight Mass on Wednesday night for the first time in two years, the mayor said. (AP)